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Investing in the energy transition

Welcome to the latest DNV GL Talks Energy podcast series, recorded live at the Singapore International Energy Week (SIEW) 2018. Each week, notable industry thought leaders join us to discuss the hot topics from SIEW and provide their insights into the main drivers behind the global energy transition.

Investing in the energy transition

Why should investors be interested in the energy industry? Carlos Albero, Global Finance Segment Leader for DNV GL - Energy, looks at new markets created by the energy transition.

In this insightful episode, Carlos explains why the energy sector, with its forecasted exponential growth in electrification, is growing increasingly attractive to investors. He describes the unique nature of the market and the critical importance of regulatory frameworks, technological maturity and market revenue projections when making investment decisions, before giving us some investment advice of his own. He also talks about the positive role competitive energy markets can play in the energy transition but highlights the work still to be done, particularly in emerging economies, before national grids can support the energy market of the future.

NARRATOR Welcome to the DNV GL Talks Energy podcast series. Electrification, rise of renewables and new technologies supported by more data and IT systems are transforming the power system. Join us each week as we discuss these changes with guests from around the industry.

MATHIAS STECK Carlos, we today want to talk about financing the energy transition. And before we go into this, it would be great if you could give us a little bit of background about yourself.

CARLOS ALBERO So, I’m a mechanical engineer by training. I joined DNV GL ten years ago. I’ve been working mainly with development banks and corporate banks in financing projects all over the world, especially Spain and Latin America – lots of projects in Mexico, Brazil, Chile – and working with all kinds of investors, from the development banks that I mentioned before to equity investors, investment funds, pension funds, so all kinds of stakeholders within the finance world.

MATHIAS STECK To get us started, maybe you can share with us what is happening in the energy industry which makes it interesting for investors.

CARLOS ALBERO Okay. So, I think that the energy industry has been targeted as a very first profitable market for the investors. So, the returns that they are expecting are being met by the energy projects. But then, it’s a market in which we are forecasting an extremely exponential growth. We are expecting lots of energy towards the electrification market. So, that means that we will need further plants that will generate more electrical energy in order to provide the transition that we need. And I think that this has been spotted by the investors. They see it as a growing market, so that’s why it provides them the framework that they need in terms of having a forecastable future into their investments, so they are able to get the returns along the time that they expected.

MATHIAS STECK Right. Also here on the Singapore International Energy Week, we had a few discussions about financing. And one theme which came up was that there is also somehow a responsibility maybe to make banks and investors more familiar with investments into the energy sector. So, what makes investing in the energy infrastructure different from investing in, let’s say, a car company or telecommunications industry?

CARLOS ALBERO Okay. So, I would say that the particularities of investing in energy is that there’s a history that comes in the past, especially in renewables, talking about feed in tariff schemes, in which it was very easy to forecast that your asset was going to have these kinds of revenues for this amount of time. And this has been changing quite a lot, in the last few years. We are moving from those schemes towards new merchant schemes, and that means market risk. So, that’s something that is new to investors and it’s something that they have to take into account while they’re getting into those investments. I think that comparing to those sectors that you were mentioning before – telcos or automation industry – energy is different because you have an asset that is generating electricity for a very long period. You need to operate the asset, you need to keep that asset with the performance levels that you were forecasting before. And that requires not just sitting down in your chair and letting someone else do the job. It’s also doing a proper asset management, doing a surveillance on your activity, and on the market, at the same time. So, it’s not just about gaining efficiency, like it could be in the automation industry, and taking for granted the market side in terms of there will always be an amount of people that will be buying cars, but you have to take care of how the environment is growing around the energy market. So, I think that this kind of looking to the both sides is a unique insight from the energy market.

MATHIAS STECK So, what kind of information may investors lack or what value may they underestimate to then really make an investment decision?

CARLOS ALBERO Okay. So, we’ve had lots of experiences, especially on the merchant acquisitions market. The merchant acquisitions market works on a very different basis than the rest of the projects that we usually work in, like due diligence, in which you have a very defined timeframe. In this case, it happens the same, but it’s much shorter, so decisions are very swift. So, in this kind of rush towards the M and A processes, what we feel that there’s a lack of is that people usually don’t look at the conditions in which the asset has been operating in the past, and what kind of upsides or downsides you may have in your assets. So, sometimes, you need a little bit of time to take care of those things, and we usually don’t have those in these kinds of operations. So, I would suggest that a very detailed look should be taken into the operational history of the assets, which tells you not just the condition in which the asset is today. You can take the car to your car wash and it will look very nice, but if you open the hood and look at it, it may look very different. So, that’s what we think we should provide to the investors that are getting into this market – a very detailed view under the hood of the renewable assets or conventional assets as well.

MATHIAS STECK Right. So, fortunately, the emergency of transition of the energy system has been, kind of, understood now. But still, we hear from investors that there’s money available, but sometimes, they have trouble to find projects.

CARLOS ALBERO Yes.

MATHIAS STECK Bankable projects, whatever they are, sizable enough. So, on that side of the spectrum, what is holding us back to move faster to invest more in renewable energy projects?

CARLOS ALBERO I think it’s exactly as you suggest – the money is there. So, there’s a lot of interest in the market to get money into the energy business. The main issue is to find what we call bankable projects. And what the finance segment means by bankable is that they have the requirements in order to meet the risk committees with enough certainty to lend the money to those projects. And that means that they have to have a reliable technology. So, there’s no room for experiments at this time. We need to have a reliable technology, which is the case of wind, solar at this time, but also the other energy sources. It’s also to have the proper framework. And it’s the regulatory framework which lacks off, mainly in emerging economies, but also in some stable countries. In lots of stable countries, for instance, storage does not have a proper framework at this time. And it could be something that will be developed in the future that will allow further integration of renewables as well. But in the emerging economies, to have a proper development phase of the projects in which land rights, connection agreements, PPAs are being able to be set on a stable, legal way – that’s, I think, one of the pending milestones in most of these emerging economies. Besides this, it’s just a matter of establishing the proper market rules along time. So, for valuable energies, for instance, it’s very important to have a floor price in the market, that provides lots of certainty. But besides this, if there’s a proper assessment of the risks in an electrical market, you can forecast what’s going to happen. Electrical markets have a lot of inertia in terms of the costs of the energy changing. So, if you’re able to do an assessment on that, that provides lots of comfort to the investors. So, I think that these three things are the major ones, the three dimensions that we are looking at – regulatory framework, technology and the market revenues.

MATHIAS STECK Talking about the comfort of investors, maybe you can also give us some investment advice. With all the build-out of renewables dependant on the penetration ratio, there may be new technologies required – storage, flexibility, demand response. If you would have to make a decision or give any advice, what you would put your money on, what would that be?

CARLOS ALBERO I would think that storage and grids would be my major winning horses. For certain, once the penetration levels of renewables are higher, we need more flexibility from the grid side. And that provides… comes from two sides. The number of tools that you have in hand in order to cope with variability. So, once you have no wind or no sun, how do you get the energy that you need from conventional power plants, from storage plants? That’s the kind of flexibility that is needed by the system. And also, how strong the grid in which you are connected is. So, in countries like the European countries or the US, where you have a very strong and meshed grid, you have a lot of tools, if you have a shutdown in a certain substation, to get the backup power from different sides. Which it doesn’t happen in other areas of the world like Southeast Asia or Africa, in which the development of such grids is simply not feasible within a very short timeframe.

Recently, I was in the Mauritius island in the African Energy Congress, and it was very interesting to see the people from Morocco talking about the auction that they have run there, and how they have been able to integrate one gigawatt of renewable power in their grids. It’s something that they are able to do that, because they have been working 20 years on their grids, and it’s something… it’s a time that most of the countries do not have. So, times are reducing, and we need to find new, innovative solutions in certain other countries. So, micro grids and minor grids are a feasible solution for that. And in that case, storage comes again as a major player. If you are able to get cheap wind turbines, cheap PV panels, and merge them with storage, that’s the winning solution to provide a stable and a price-effective grid in a very short timeframe, in a defined regional area. So, I would definitely go for those two – energy storage and grid strengthening.

MATHIAS STECK Right. One major success factor for renewables is definitely that the prices have come down so substantially. And one reason for this is that technology has matured, so the technology cost went down dramatically in both wind and solar. But there’s also another mechanism which was accelerating this maybe, and this is auctions. And we have seen auctions especially in solar, I would say, but also I remember in offshore wind, in Europe, arriving at really, really competitive kilowatt hour prices. But there is also a flipside to that. Number one is it’s not so interesting maybe anymore to finance these projects for equity investors because the yield rates are so low; and you might hamper things like local content because only the very, very experienced players can maybe deliver to these low margins. What is your take on this, also with view on the Asia-Pacific region?

CARLOS ALBERO So, I think that auction is a mechanism that provides low pricing. That’s for sure. There’s no other mechanism that provides a lower price. We’ve seen that, for instance, in Mexico, where $17 per megawatt hour has been achieved on a wind farm, onshore. So, it was an unbelievable level just five years ago. And how can you come to those low prices? Frame agreements, lots of expedience, a very strong financial arm, taking bits and pieces from every single part of a project to do savings and to be able to provide a low energy price. I think the auctions are a very good way of having this. But having this said, what we are seeing from auctions is that it’s also a very good way of shaping your market. So, if you are a country that… or an area that you are very dependent on fossil fuels, that you have a very defined energy matrix, you may use your auctions in order to diversify your matrix, in order to allow other energies to penetrate the grid, and to balance your system towards the targets that you may want to achieve in the next few years. Things like the integrated resource planning processes in which you take a look at your system, see how the demand is going to evolve, see how the energy matrix is going to evolve and seeing the gaps that you will have in the next 20 years; in order to fill those gaps with the kind of generation that you may want to have in order to comply with the target emissions, environmental stewardship – whatever you want to… whatever targets you may want to comply with – it’s a very good exercise. So, I would say that, yes, auctions are a good system. But they have to be very well thought in terms of achieving with them the targets that you wish for your country, for your area. I think in Asia-Pacific, it’s still something that it has to be developed, but there are lots of countries, like you were mentioning before – we were mentioning, we were saying Mexico, Germany, Spain – they have open rounds of auctions. Belgium recently, with the offshore wind. And there are lots of examples on that. But for all the regulators and decision-makers that may be watching or hearing us, I would say that, first, think about the targets that you want to achieve with these auctions, not just low price, and then settle up the framework. Because if that happens, you will have lots of interest, lots of investors, and you will get the projects done according to what you are expecting.

MATHIAS STECK Very good, Carlos. We are recording this episode here at the site of the Singapore International Energy Week 2018. As a final question, I would like to ask you, what is your major take-away from the conference?

CARLOS ALBERO I think I have two major take-aways. The first one is that we have a lot of work to do in Southeast Asia. There’s a very conventional energy matrix here. There’s a lot of work to do in grids as well, and not just the centralized grids, but also the decentralized ones or isolated ones. And then, this has to come hand by hand with the regulatory framework work. So, that’s one of the main take-aways. The second one is that it needs to happen – this kind of mind shift towards these kinds of schemes that we were talking before, towards auction schemes, towards a diversification of the matrix – because we’re running out of time, we need to move faster. That’s what our energy transition outlook says. We need to accelerate this transition. And it’s not the time to play the ostrich now and hide the head in the sand; it’s time to stand up and do as much as possible for the energy framework that we are working at. So, I would say that I have those two take-aways – the major one about the regulatory framework, and the other one about the decarbonization of the matrix in Southeast Asia. So, those are the two things that I take with me.

MATHIAS STECK Very good. Thank you very much, Carlos, for your good insights and the investment advice. That was Carlos Albero, Global Finance Segment Leader of DNV GL Energy.

NARRATOR Thank you for listening to this DNV GL Talks Energy podcast. To hear more podcasts in the series, please visit dnvgl.com/talksenergy.